When you buy a business, there are usually two agreements that are signed. The initial agreement has the important terms of the deal – such as price, terms, training, what assets are included, and contingencies. The usual contingencies are for due diligence, financing, obtaining a lease if the location is important, and agreeing on the final purchase and sale agreement. Some buyers make the mistake of wanting to deal with the contingencies (the cart) before an agreement is signed(the horse). This is a mistake.
The buyer may not think of it in the way I have presented it. Some are financial analysts who need to dig deeply into the numbers before they make an offer. That’s understandable because an offer is based on the numbers – particularly cash flow. However, the reports that we put together on a business include the detail from the tax returns for the past 3 years. We also show how the owner’s cash flow is calculated from these numbers. This should be enough information to present an offer. Later, during due diligence, if the buyer finds a reason that the numbers presented don’t give an accurate picture of the business, that is the time to discuss a change in the price.
Obtaining financing is a normal contingency in the initial agreement. It’s understandable that a buyer would want to know that they are likely to get the financing. The seller wants to know also. Sellers should not sign the initial agreement until they have received some information on the buyer to determine that the buyer is likely to get the financing. We can also refer the buyer to lenders who will give the buyer feedback on their loan application. It’s not necessary to go through the entire loan application process before presenting an offer.
There are a couple good reasons not to do due diligence or go deep into a loan application before signing the initial agreement. The first is that while a buyer is doing this, another buyer can put the business under agreement. I’ve seen several instances of this. I once had a landscaper who was working on buying another landscaping business. The basics of the deal were worked out. Then, before presenting a written offer, the buyer started asking lots of questions. He was also off on his winter break, so didn’t work on the deal all the time. Several weeks went by until, in one day, another buyer presented an offer, negotiated a deal, and signed the agreement to buy the business.
The most experienced, savvy buyers, move quickly. I once had a private equity buyer sign the confidentiality agreement on a Wednesday, have a conference call with the seller on Friday, visit the business(they had to fly in) on Monday, and sign an LOI by Friday. An individual buyer signed an agreement to buy a business with real estate for several million dollars in a week. Both of these deals closed at the initial agreed price. In most cases, buyers who move this quickly are experienced business people who know the industry and recognize a good business when they see it.
Another reason to sign an agreement before due diligence and getting financing is that not doing so can be a waste of time – the buyer’s and the seller’s. Due diligence and obtaining financing take a lot of time. Be sure you spend the time on a deal you have under agreement.
Don’t put the cart – due diligence and financing – before the horse – signing an agreement to buy the business. If you do, you will be a happier buyer and buy the business you want.